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Benchmarks

by Fairtree

Every unit trust in South Africa has to publish a fund benchmark. In the case of equity funds, this benchmark is usually market index, which indicates the standard against which the fund should be measured.

“The benchmark is there so that you know what the fund manager is trying to achieve,” explains Morningstar investment analyst Gerbrandt Kruger. “It gives you an idea of their objective.”

As portfolio manager at Fairtree Capital, Rademayer Vermaak, points out, there are two parts to this:

“The benchmark allows you to measure the performance of the manager, but also the relative risks that the manager is taking against that benchmark in order to try to outperform,” he says.

Investors may be under the impression that this means that all unit trusts in the same category use the same benchmark. However, this is far from the case.

Figures from Morningstar, captured in the table below, show that active managers in the South African general equity category are using 14 different benchmarks between them.

Every unit trust in South Africa has to publish a fund benchmark. In the case of equity funds, this benchmark is usually market index, which indicates the standard against which the fund should be measured.

“The benchmark is there so that you know what the fund manager is trying to achieve,” explains Morningstar investment analyst Gerbrandt Kruger. “It gives you an idea of their objective.”

As portfolio manager at Fairtree Capital, Rademayer Vermaak, points out, there are two parts to this:

“The benchmark allows you to measure the performance of the manager, but also the relative risks that the manager is taking against that benchmark in order to try to outperform,” he says.

Investors may be under the impression that this means that all unit trusts in the same category use the same benchmark. However, this is far from the case.

Figures from Morningstar, captured in the table below, show that active managers in the South African general equity category are using 14 different benchmarks between them.

Benchmarks used by active SA general equity unit trusts

Source: Morningstar

The Swix and All Share Indices are clearly the most popular, followed by a peer group average. Few managers are using capped indices, and a handful benchmark themselves against price return indices, which do not take into account the reinvestment of dividends.

The first question this raises is whether this makes any difference to the average investor.

“I don’t think most investors know the difference between the All Share Index, the Capped All Share Index or the Swix,” says Kruger. “Typically when they look at the market they look at All Share Index returns, and don’t realise that their fund might be benchmarked against something else.”

So should it matter to investors what benchmark is being used? Pieter Koekemoer, the head of personal investments at Coronation says that the answer really depends on its purpose.

If the manager uses a ‘clean slate’ approach, which means that they pay no attention to the benchmark when picking stocks, then the benchmark is only there to help you evaluate whether you are receiving value for money. If however the manager is charging performance fees for outperformance, then it becomes more important.

“You then have to ask whether the benchmark is fair,” Koekemoer says. “For example, does it make sense for a fund with high equity exposure to use an absolute benchmark, such as cash-plus. Or if a fund uses a peer group average, what is the quality of that peer group?”

Both Koekemoer and Vermaak argue that any benchmark should be investable. In other words, it should represent a genuine alternative portfolio that an investor could hold.

“The way we think about it is that you should try to find the best representation of how an investor could construct a similar portfolio in a passive manner,” says Koekemoer. “That makes for a good benchmark – one that an investor can replicate and best expresses the opportunity set you have as an active manager. If we want to prove that we can add value, we need to show that over time we can outperform that quantitative benchmark.”

Vermaak adds that this is why peer group averages are problematic.

“If the market is investable, then I believe that the market should be the benchmark,” Vermaak says. “I think it’s dangerous territory to benchmark yourself against your peers, particularly if most of them underperform an investable benchmark.”

Coronation’s Koekemoer adds that peer group benchmarks also don’t acknowledge the options available to investors.

“It inherently assumes that the alternative investment is another active manager,” Koekemoer says. “That may have been true 20 years ago, but with a fairly sophisticated passive market it isn’t the case any more.”

A fund that uses the price return rather than the total return index should also have an overwhelmingly good reason for doing so. Dividends make up a significant part of any investment return, and if you’re not taking those into account in your benchmark, then the bar you are setting yourself as a fund manager is naturally much lower than one where the reinvestment of dividends is factored in.

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